Debate: $700 billion US economic bailout

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Is the $700 billion bailout plan for the 2008 US financial crisis a good idea?

Background and context

In September of 2008, following the failure of several major US financial institutions, U.S. lawmakers proposed an initial bill to bailout the U.S. financial system. This measure, which involved the government acquiring or insuring as much as $700 billion of troubled mortgage-backed securities, was intended to reduce the level of uncertainty regarding these assets and restore confidence in the credit markets.

Following several financial crises among major U.S. financial institutions in September 2008, including the federal takeover of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, an emergency Federal Reserve loan to American International Group, and the merger of Merrill Lynch into Bank of America—events considered part of the on-going financial crisis of 2007–2008—the United States Secretary of the Treasury Henry Paulson proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of illiquid securities that are backed by troubled housing loans. The plan was immediately backed by President George W. Bush and negotiations began with leaders in the United States Congress to draft appropriate legislation. On September 28th, however, legislation supporting the plan was rejected in the House of Representatives. It is, nevertheless, possible that a similar piece of legislation with a $700 billion bailout will be passed. In any case, the debate regarding the merits of a $700 billion bailout continues. The debate surrounds numerous questions. Is a $700b bailout necessary to avoid financial crisis? Or is the US economy stronger than many believe, and a bailout less important than some have believed? Is an immediate solution necessary? Or, is there time to debate alternatives? Is government intervention in the markets appropriate on principle? Can it help solve the fundamental problems in the US economy, or will it only add to the problem? Does the economy need more regulation or less? Did too little regulation cause the crisis, or was too much regulation to blame? Is there a moral hazard in bailing out reckless risk-takers on Wallstreet? Should they be allowed to fail so that they learn their lesson? Would a $700 billion bailout overly burden taxpayers? Or, is it possible that taxpayers would not lose at all and possibly profit from a bail-out and the re-sale of mortgages that they are essentially buying? If the majority of taxpayers oppose the bailout, should their will be followed? Is a bailout consistent with the balance of powers in the US between the Executive and Legislative branches? Is it Constitutional?

Economics: Is the $700b "bailout" economically sound/necessary?

Yes

Not passing $700b bailout risks sending economy into major recession U.S. Treasury Secretary Henry Paulson summarized the rationale for the bailout in testimony before Congress in September, 2008 - "We must...avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy."[1]

Most economists support the $700b US economic bailout planGreg Mankiw, Harvard economics professor. "A Defense of the Paulson Plan". 25 Sept. 2008 - "The Treasury proposal to rescue the financial system has gotten a lot of grief lately, especially from the community of economics professors. A smart friend, who knows more about this topic than I do, emails me his response to the critics: 'Academic economists don't like the Treasury plan, but nearly all of the Wall Street economists are for it. You don't have to be all that cynical to say that the Wall Street economists are talking their book. But I'd like to think that there is at least in part a sense in which they are more attuned to the reality of the situation in credit markets -- that last week we were a day or two away from a breakdown of the financial system.'"

$700 billion bailout plan is too little too late"Proposed $700 Billion Bailout Is Too Little, Too Late to End the Debt Crisis; Too Much, Too Soon for the U.S. Bond Market". Weiss Research Inc. 25 Sept. 2008 - "New data and analysis demonstrate that the proposal before Congress for a $700 billion financial industry bailout is too little, too late to end the massive U.S. debt crisis...There should be no illusion that the $700 billion estimate proposed by the Administration will be enough to end the debt crisis. It could very well be just a drop in the bucket."

$700b bailout would increase US deficit and interest rates"Proposed $700 Billion Bailout Is Too Little, Too Late to End the Debt Crisis; Too Much, Too Soon for the U.S. Bond Market". Weiss Research Inc. 25 Sept. 2008 - "II. Too Much, Too Soon for the U.S. Bond Market. There should also be no illusion that the market for U.S. government securities can absorb the additional burden of a $700 billion bailout without putting dramatic upward pressure on U.S. interest rates. The Office of Management and Budget (OMB) projects the 2009 federal deficit will rise to $482 billion. But adding the cost of announced and proposed bailouts, now approximately $1 trillion, it is undeniable that the federal deficit could double or triple in a short period of time, driving interest rates sharply higher and aggravating the very debt crisis that the bailout plan seeks to alleviate."

$700 bailout wrongly trusts culprits to solve crisis"We Need Another Choice". Daily Kos. 23 Sep. 2008 - "there's little stomach for bailing out what essentially turned into a Ponzi scheme backed by the largest players in the financial industry. Yes, they say they need a massive, trillion-dollar influx of cash to patch the crisis they themselves caused via irrational pricings of mortgage-related derivatives. But when someone has proven to be utterly financially incompetent, giving them a trillion dollars in the hopes that they merely don't blow it all too quickly is not confidence-inspiring."

Immediacy: Is/was the passage of a $700b bill urgent?

Yes

$700b bailout must be implemented immediately to avoid crisis Rep. Spencer Bachus, Republican of Alabama and Ranking member of the House Financial Services Committee - "Our time has run out. We're going to make a decision. There are no more alternatives. There are no other choices. Just this one choice. And I don't know about you, I believe every member of this body feels as if there's an awesome responsibility on our shoulders. This will be the most difficult decision I make in my 16 years in this body. And I have decided that the cost of not acting outweighs the cost of acting..."[4]

$700 it is more important to pass a plan than for it to be perfect. Many critics of the $700 billion bailout argue that there are problems with the bill, and that little things here and there should be added. Some argue that there are disadvantages to the plan compared to the relative advantages of certain alternatives. But, as these nuances and alternatives are debates, and the passage of a bill is delayed, the economic crisis will continue its downward spiral. The advantages, therefore, of making a bailout plan perfect are outweighed by the costs of delaying the passage of a solution.

A good solution to the US economic crisis cannot be rushed Sen. Richard Shelby, R-Ala., the top Banking Committee Republican - "I am concerned that Treasury’s proposal is neither workable nor comprehensive. In my judgment, it would be foolish to waste massive sums of taxpayer funds testing an idea that has been hastily crafted, and may actually cause the government to revert to an inadequate strategy of ad hoc bailouts."[5]

Deregulation and free-market ideologies caused US economic crisisRobert Kuttner. "Learning from 1929". The American Prospect. 30 Sept. 2008 - "the other lesson [from 1929] was the one "we" forgot -- not to let banks and other financial institutions turn themselves into casinos. It is helpful, in the spirit of Tonto's historic interrogatory to the Lone Ranger -- "What you mean, we?" -- to unpack that "we." The "we" who forgot the lessons included first and foremost Republican ideology -- deregulate everything and let markets run wild; secondly Bush administration regulatory officials who disdained even the regulations on the books; and third, the Wall Street Democrats who were de-regulation's willing enablers."

Too much regulation, not too little, caused US economic crisisJeff Jacoby. "Frank's fingerprints are all over the financial fiasco". Boston Globe. 28 Sept. 2008 - "while the mortgage crisis convulsing Wall Street has its share of private-sector culprits they weren't the ones who 'got us into this mess.' Barney Frank's talking points notwithstanding, mortgage lenders didn't wake up one fine day deciding to junk long-held standards of creditworthiness in order to make ill-advised loans to unqualified borrowers. It would be closer to the truth to say they woke up to find the government twisting their arms and demanding that they do so - or else...The roots of this crisis go back to the Carter administration. That was when government officials, egged on by left-wing activists, began accusing mortgage lenders of racism and 'redlining' because urban blacks were being denied mortgages at a higher rate than suburban whites."

$700b bailout is slippery slope to socialism Rep. Jeb Hensarling, Republican of Texas - "I fear that, under this plan, ultimately the federal government will become the guarantor of last resort, and Madam Speaker, that does put us on the slippery slope to socialism."[6]

No

$700b plan bails-out risk-takers who need to learn lessonMark Stanford. "A Bailout for All Our Bad Decisions?". Washington Post. 26 Sept. 2008 - "For 200 years, the 'business model' in our country has rested on a simple fact: that while one may reap rewards from taking risks, one should also be prepared to face the consequences of those risks. Some of the proposed actions with regard to the credit market turn that business model on its head -- absolving those who took too much risk, or bought too much house, from the weight of their own choices. If Congress passes the proposed bailout, we will be destined to have far greater problems in time, leaving those who are prudent in their finances to foot the bill for those who are not."

Yes

$700b is no Wallstreet giveaway, but a taxpayer investment. The nature of the $700b bailout does not, by its nature, bailout Wallstreet fat-cats. It is not a cash giveaway to Wallstreet banks. It involves, rather, government and taxpayers purchasing mortgage assets. These assets are then owned by the government and taxpayers and can even later be sold for a profit for taxpayers. This is, therefore, obviously not a cash-giveaway to Wallstreet fat-cats.

Executive pay restrictions can be passed along with $700b plan US Secretary of the Treasury Henry Paulson - "The American people are angry about executive compensation and rightfully so. Many of you cite this as a serious problem and I agree. We must find a way to address this in the legislation, but without undermining the effectiveness of this programme."[7]

Taxpayers: Will the $700 billion bailout help or hurt taxpayers?

Yes

$700b plan may result in few losses or actually profit taxpayers Secretary of the Treasury Henry Paulson - "When you look at the money that is spent to purchase assets that will be held and sold, and the price you will get for those assets will be based upon how the economy does, the pace at which the housing markets recover. But the ultimate cost will be well below what was actually spent for the assets."[9]

$700b plan is better for economy/taxpayers than doing nothing US Secretary of Treasury Hank Paulson - "The ultimate taxpayer protection will be the market stability provided as we remove the troubled assets from our financial system. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund everyday needs and economic expansion."[10]

Financial Services Roundtable - "The sophisticated interconnectivity of institutional market participants, individual investors, small businesses and pension funds - both large and small – reflects the broad range of Americans who have a great deal at stake in this debate. If the market conditions that have paralyzed the credit markets are allowed to continue and become exacerbated by inaction, every American‘s economic well-being could be at risk. The recovery plan, in its most general sense, offers an opportunity to return to an orderly market while assuring maximum protection for taxpayers and a path to divestiture of private funds purchased by the public facility. While we understand the details of the proposal are complex, we encourage Members of Congress to enact a bill based on the Treasury proposal as soon as possible."[11]

What does "at any one time" actually mean to economists? It means that if everything we American taxpayers buy re-evaluates down to zero, we get to buy more. That's hardly taxpayer 'protection.' With several hundred billion dollars of write-downs already announced this year by the part of the industry compelled to post their losses, it's a safe bet that $700 billion worth of the junkiest assets in existence will be heading to zero the second they are purchased."

Public opinion: Does public opinion favor or oppose the bailout? Does it matter?

Yes

Taxpayer opposition to $700b plan is ill-informed; ignore it Taxpayer opposition to the $700b bailout plan is not well informed. It is based on uninformed opinions regarding the specific circumstances of the financial crisis and the nature of the $700b bailout plan. While opposition needs to be acknowledged, it should not be followed.

Leadership crisis is only worsened by not passing $700b plan Government may lack credibility among the public. Yet, this public perception has no relation to the actual capacity of government to solve economic problems. The $700 bailout plan provided a good means to solving the economic crisis. It should have been adopted irrespective of public perception. Furthermore, Congressmen that voted against a bailout plan obviously cannot rely on the argument that the people "don't trust us" to justify their "no" vote.

No

$700b bailout is unjustified over majority taxpayer opposition A Bloomberg-Los Angeles Times poll of more than 1,400 Americans, found 55 percent of respondents opposed the 700b bailout plan. 33 percent were in favor and 14 percent weren't sure.[13] In a USA Today/Gallup Poll conducted on September 24th just 22% favoured Mr Paulson’s proposal while 56% wanted something different; only 11% preferred that no action be taken.[14] It is inappropriate for Congress to pass legislation over the opposition of the taxpayers they represent.

Powers: Does the $700b bailout give reasonable power to US Treasury?

Yes

$700b bailout includes oversight/transparency Roy Blunt (R-MO) - "We believe that all of the transparency you could possibly hope to have in a government program is here. All of the oversight is here. In fact, if anything, we may have overdone the oversight."[15]

Financial crisis requires and justifies strong executive powers. The Constitution of the United States is designed to allow Congress to give major power to the Executive branch, in this case the Department of Treasury, in order to respond quickly and decisively to crises. The 2008 financial crisis is a good example of a situation in which Congress is justified in granting the Secretary of the Treasury with $700 billion to forestall what some fear could be the next Great Depression. This is appropriate and Constitutional, not least because it is necessary in the preservation of the Union.

Alternatives: How does the plan compare with the alternatives?

Yes

Paulson Plan justified without warrants; taxpayers still protectedGreg Mankiw. "A Defense of the Paulson Plan". Greg Mankiw Blog. 25 Sept. 2008 - "2. 'Taxpayers will be better off if Treasury gets warrants.'...This is essentially the assertion made in David Leonhart's column in the NY Times on Wednesday. And it again illustrates that we would all be better off if high schools taught the Modigliani-Miller theorem. MM implies that the price of the asset (again,assuming the auction gets it right) will adjust to offset the value of any warrants Treasury receives. In this case of a reverse auction, imagine that the price is set at $10. If Treasury instead demands a warrant for future gains of some sort, then the price will rise in the expected amount of the warrant -- say that's $2. Then the price Treasury pays for the asset will be $12. Some people might prefer to get $12 in cash and give up a warrant worth $2 in expected value. Fine, that's a choice to be made. But the assertion that somehow warrants are needed is simply wrong."

No

Government should buy stock in banks, not just bail them out"The $700+ Billion Bailout--Posner". The Becker Posner Blog. 25 Sept. 2008 - "A more palatable approach would be for the government to drive a Warren Buffett style hard bargain, in which, rather than buying anything from banks, the government would invest in them in a form, such as purchase of newly issued preferred stock, or bonds with a long maturity, that would augment the banks' capital and thus enable banks to make more loans. That would avoid conferring a windfall on the banks by overpaying them for their bad securities; no one thinks Buffett is conferring a windfall on Goldman Sachs. After the industry was back on its feet, the government could sell the bank stocks or bonds that it had acquired."